India's financial distress mechanism is in crisis. Companies that fall into hard times spend six to eight years trying to resolve the situation. Banks are saddled with massive amounts of non-performing loans, affecting their willingness to lend to new projects. Ultimately it is the successful honest companies and individuals who borrow and pay for these defaults. This negativity impacts growth, job creation, boost in credit market and entrepreneurship. An important measure is to make India's decadent Insolvency and Bankruptcy Regime (IBR) robust and speedy.
In the past 20 years there have been a number of attempts to reform India's IBR. The Sick Industrial Companies (Special Provisions) Act, 1985 (SICA); The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDBFI); The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) were enacted to speed up the Insolvency and Bankruptcy Regime. (In addition the Reserve Bank of India devised the 'Corporate Debt Restructuring Scheme' that tried to sidestep the courts to resolve the financial distress.)
Presently there is no single law dealing with insolvency and bankruptcy. Prevailing IBR is not only fragmented but discriminatory as it favours just one set of shareholders (secured creditors). Multiplicity of laws has resulted into multiple adjudicatory agencies: the High Courts, the Company Law Board (CLB), the Bureau of Industrial and Financial Restructuring (BIFR) and Debt Recovery Tribunals (DRT). This gamut culminates into delay and conflict amongst different laws. As an upshot, India's IBR is described as the slowest in the world.
Recognizing that IBR in many ways is "inadequate, ineffective and results in undue delays", the Government in order to improve the ease of doing business introduced a Bill in the Lok Sabha -'Insolvency and Bankruptcy Code, 2015' , now pending before the Parliamentary Joint Committee expecting report post recess in the Budget Session. While introducing the Bill the Government said: "The Bill will consolidate and amend the laws relating to reorganisation and insolvency, of corporate persons, partnership firms and individuals in time-bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interest of all the stakeholders including the alteration in order of priority of payment of government dues and to establish an Insolvency and Bankruptcy Fund." The proposed law would make it easier for sick companies to either wind up business or engineer a quick turnaround and make it easy for investors to exit within a fixed time frame.
The spirit of timeliness informing the Bill is appreciated, particularly at every stage of Reorganisation, Insolvency and Bankruptcy Process (RIBP) and is key to its effectiveness. It is important for RIBP to recognize bad news and act quickly - a principle that is missing in the prevailing IBR.
Take the recent Kingfisher Airlines (KFA) episode as an example and how its negative impact could have been contained had there been an effective framework like the one in the proposed code, as pointed out by Ms. Anjali Sharma in her Article on 1 st April, 2016. In March 2009, KFA had a debt of ` 5,600 crore along with a negative net worth, yet lenders took no credible or coordinated action. Instead, 2013 Annual Report records higher debt at more than ` 10,000 crore with banks having additional loans of ` 2,000 crore. However, action (though delayed) when taken putting the KFA house on auction with a reserved price, the creditors suffered a serious setback as no bid came above the reserved price bringing testifying utter failure of the prevailing RIBP. The proposed code that focuses on 'speed of resolution' could have dealt differently with this situation. The Bill envisages a process that disincentivises delay at various stages. To appreciate the above let's start with the first date of default in the KFA episode. As per the Bill RIBP can be triggered by any creditor - not just by bank alone -on the date of the first default without any waiting unlike in SARFAESI, where banks can wait for 90 days before designating a default account as non-performing asset (NPA), and wait for 30 days before taking any action. The Bill empowers even operational creditors including employees and traders/creditors to trigger the process, widening the net of those whose interests are affected, as many times big/secured creditors may ignore to do so because of political or vested reasons. In KFA case the earliest publically observed default was on the employees' salaries. Under the proposed regime default to employees can be used to trigger resolution process. To prevent any harm resulting to organisation's legitimate interests after the process is triggered and completed, the law proposes to protect the organization as a growing concern. No secured creditor can take away assets. Further it is provided at the stage of triggering a Committee of Creditors and Resolution Professional (RP) - a new breed of professionals who would be responsible to devise a plan for the future working of the firm including replacing the management. This perhaps could have happened in the case of KFA in 2009. It is likely that even when RIBP was triggered as a going concern under a new management team the company would be able to contain fall in its value. Under the proposed Bill if the Creditor's Committee cannot agree on a plan to keep the company as a going concern, it would automatically go into liquidation. Significantly going further, if the big lenders with over 75% of the debt dominate the Committee, and with motivated design or under political pressure decide to undertake an extended and pretended plan, smaller creditors would get a seat on the table in the meeting and protest that would be recorded officially. Same could trickle in the media. But there is no such possibility in prevailing laws for small creditors and the matter may remain in the clutches of big players as happened in the KFA. In the United States the unsecured lenders, having lower priority than the secured lenders are given a say in IRP but provisions under the proposed Bill in this regard still remain weak. Especially knowing that they can secure their money by liquidating their collateral, secured lenders may sometimes prefer liquidation or restricting even if the latter results in higher value for the firm's equity holders. This may adversely affect the development of a market for unsecured loans knowing the importance of the market of unsecured debt to spread economic opportunity in a knowledge-based economy like India.
The Bill importantly recognizing the need to address the issue of cracking legal infrastructure including absence of nuanced and professional approach to reorganisation, IBP aims to overcome it through the route of privatization. The Bill envisages a new breed of Insolvency Resolution Professional (IRP) who will be responsible for managing the reorganization and insolvency process. The IRP will have specified qualifications and specialization in helping sick companies since there is a need to bring professional approach for effectiveness, quality and drawing for balance of interest of different stakeholders. The Bill proposes the setting up of an 'Insolvency and Bankruptcy Board of India' to regulate IRP, and professional agencies and creating utilities engaged in resolution of insolvencies. By providing for engagement of IRP, professional agencies and utilities to conduct the corporate insolvency process the proposed Bill in a way reduces courts' burden expecting them to confine only to their limited role. Another important feature is the prescription of a strict time-bound process, mandating that the decision between restructuring and liquidation should be made by IRP within six months of a firm being referred for bankruptcy process. Under certain circumstances there can be an extension of three months after which the firm will be liquidated to settle the claims. It also provides for Fast Track Corporate Insolvency Resolution Process in a certain situation to be completed in 90 days. Time-boundness is the key.
Concerned about the multiplicity of adjudicators with overlapping jurisdictions, the Bill seeks for designating National Companies Law Tribunal as the adjudicating authority for companies and limited liability partnerships and DRTs for individuals and partnership firms. More importantly under the Bill priority with regard to distribution of proceeds following liquidation of the company is also provided: Firstly meeting the charge for IRP cost and liquidators cost in full proceeds be used to clear debts owed to secured creditors and then to pay workmen's dues for 12 months, unpaid dues to other employees, and dues owed to unsecured creditors in that order. Government is to take for two years, other debts and preference shareholders and equity shareholders will come last.
It is important in the light of episodes like KFA and rising allegations of siphoning of money in the shape of NPL that Bill proposes a tough stance towards issues like willful default or deferment by prescribing monetary penalty and jail term upto five years for concealment of property, defrauding creditors and furnishing false information.
Despite limitations taking holistic approach the Bill if approved will bring an effective, speedy and purposeful Insolvency and Bankruptcy Resolution Regime.